Background
Stealth Enterprises Pty Ltd (Stealth) owned and operated a brothel in the Australian Capital Territory known as “The Gentlemen’s Club”. The brothel’s premises were insured against the risk of property damage under an “Adult Industry Insurance Policy” held with Calliden Insurance Ltd (Calliden). Calliden specifically targeted this Policy at adult retail stores, adult party planners, brothels, adult mail operations, swingers clubs, strip clubs and lingerie restaurants.
The sole director of Stealth and his brother, the brothel’s manager, were members of the Comancheros bikie gang, a group reputed to be involved in organised crime. Stealth did not disclose this fact before Stealth entered into the policy which it held with Calliden.
During the policy period, fire damaged the brothel’s premises.
Calliden denied Stealth’s claim for indemnity because it had failed to disclose that its sole director and his brother were members of the Comancheros and that the brothel’s registration had expired at the time of renewal. Calliden contended it would not have entered into the policy had those matters been disclosed.
At first instance, the Supreme Court of New South Wales upheld Calliden’s position. The New South Wales Court of Appeal has decided that Stealth is entitled to indemnity and upheld Stealth’s appeal.
The Duty of Disclosure
For the last thirty or so years, Section 21 of the Insurance Contracts Act 1984 (Cth), as amended from time to time, has largely[1] outlined an insured’s duty of disclosure.
Before the relevant policy is entered into, the insured has a duty to disclose every matter that:-
is known to the insured; and
is a matter which the insured knows is relevant to the insurer’s decision to accept the risk and, if so on what terms; or
is a matter which a reasonable person in the circumstances could be expected to know is relevant to the insurer’s decision to accept the risk and if so on what terms.
There are exceptions to this duty (such as matters of common knowledge or matters known to the insurers) which did not attract debate in this case.
Section 28 of the Insurance Contracts Act outlines the remedies available to an insurer in the face of a breach of Section 21. Those remedies include addressing any prejudice which the breach has caused the insurer. That prejudice may reflect the fact that the insurer would not have entered into the policy at all.
The New South Wales Court of Appeal held that Stealth’s breach of Section 21 was limited to its failure to disclose the lapsed registration but held that Calliden would have still entered into the policy had that lapse been disclosed.
But what about the membership of the bikie gang ? Did Stealth’s failure to disclose that fact constitute a breach of Section 21 ?
The Decision of the New South Wales Court of Appeal
Known to the Insured
Stealth obviously knew that its sole director and his brother were members of the Comancheros.
Actual Knowledge of Relevance
Knowing that a matter is relevant to the insurer’s decision to accept the risk and, if so, on what terms requires “considerably more” than belief, suspicion or even strong suspicion[2].
Calliden accepted that Stealth did not have a sufficient appreciation of the relevance of the membership of the Comancheros to the insurer’s decision to accept the risk and if so on what terms, to constitute the requisite level of actual knowledge.
So what about the reasonable person in Stealth’s circumstances?
Reasonable Person’s Knowledge of Relevance
The starting point is to identify the objective circumstances of the insured which can be attributed to the reasonable person. Here those objective circumstances were the nature of Stealth’s business, the type of insurance sought, the identity of the insurer, the circumstances in which the insurance was entered into and the fact that Stealth’s sole director and his brother were members of the Comancheros.
Subjective circumstances such as what it meant to be a member of the Comancheros or what the insurer’s underwriting guidelines were, could not be attributed to the reasonable person.
Clothed in those objective circumstances, the reasonable person could be expected to know that:
the policy was intended to cover property and liability risks associated with brothels in the Australian Capital Territory;
the policy was offered through a broker and insurer specialising in the insurance of this type of risk;
the insurer would appreciate that the use of premises as a legal brothel brought with it an increase in the risk of property damage or liability all of which the insurer would take into account in its assessment of the risk which it was underwriting;
the proposal form did not direct any questions to the insured about its association with gangs such as the Comancheros;
the Notice of the Duty of disclosure suggested that there were certain types of matters that did not have to be disclosed; and
even though Stealth’s sole director and his brother were members of the Comancheros, there was no evidence that the Comancheros were involved in the operation or management of the brothel.
The New South Wales Court of Appeal held that a reasonable person in Stealth’s circumstances would not have known that the matters about which it could be expected to know, were relevant to the insurer’s decision to accept the risk and if so on what terms because there was nothing so known that placed Stealth outside the general risk that Calliden was underwriting.
And this conclusion was consistent with the questions which Calliden asked in its proposal form and its underwriting guidelines all of which were silent about any membership of a group like the Comancheros.
Outcome
Calliden was ordered to indemnify Stealth in the sum of $500,000 plus costs.
Conclusion
Whether you consider this outcome surprising or not, there is a clear message about the roles which a proposal form and its questions can play in addressing the knowledge requirements of Section 21.
Running a Section 21 case where there is no proposal form or where its contents are silent about the “non-disclosed matter” can present insurers with some real challenges. A simple question about directors’ associations would have delivered a completely different outcome in this matter.
This matter may go to the High Court but it is not entirely clear what would attract its attention. But then those are always famous last words.
[1] There are some qualifications which are not relevant to this note.
[2] Permanent Trustee of Australia Ltd v FAI General Insurance Company Ltd (2003) 214 CLR 514 at 531
